Elena Meschi and Marco Vivarelli CSGR Working Paper Series 232/07 July 2007

CORE Metadata, citation and similar papers at core.ac.uk Provided by Warwick Research Archives Portal Repository TRADE OPENNESS AND INCOME INEQUALITY IN DEVELOPING COUNTRIES Elena Meschi and Marco Vivarelli CSGR Working Paper Series 232/07 July 2007 1 Trade Openness and Income Inequality in Developing Countries Elena Meschi and Marco Vivarelli CSGR Working Paper Series 232/07 July 2007 Abstract: This paper discusses the distributive consequences of trade flows in developing countries (DCs). On the theoretical side, we argue that the interplays between international openness and technology adoption may constitute an important mechanism leading to a possible increase of income differentials in the liberalizing DCs, trough skill enhancing trade. We use a dynamic specification to estimate the impact of trade on within-country income inequality in a sample of 70 DCs over the 1980-1999 period. Our results suggest that total aggregate trade flows are weakly related with income inequality. However, once we disaggregate total trade flows according to their areas of origin/destination, we find that trade with high income countries worsen income distribution in DCs, both through imports and exports. This finding provides a preliminary support to the hypothesis that technological differentials between trading partners are important in shaping the distributive effects of trade openness. Moreover, after testing for the differential impact of trade in middle income countries vs low income ones, we observe that the previous result only holds for middle income countries (MICs). We interpret this evidence by considering the greater potential for technological upgrading in MICs both in terms of their higher “absorptive capacity” and in terms of their superior ability in serving the differentiated and high-quality markets of the developed world. Keywords: globalization, within-country income distribution, technology transfer, developing countries, LSDVC estimator. JEL Classification: F16, O15, O33 Corresponding author: Prof. Marco Vivarelli Facoltà di Economia Università Cattolica Via Emilia Parmense 84 I 29100 Piacenza [email protected] * Previous versions of this paper have been presented at the University of Ancona, at the University of Siena (Inequality Summer School, Siena, 17-24 June 2007) and at the 16th National Scientific Conference of the Italian Association for Comparative Economics (AISSEC, Parma, 21-23 June 2007); we wish to thank the discussant Paolo Piacentini and all the participants for their useful comments and suggestions. Precious insights by Mariacristina Piva are also gratefully acknowledged. 2 1. Introduction Since the beginning of the ’80s, several developing countries (DCs) have followed the path of trade liberalisation and have opened their economies towards international markets. Although the actual patterns of this process have differed across regions, on the whole trade flows have significantly increased over the last three decades and the diffusion of technology between countries has become more rapid and widespread. Whether such a process of globalisation is associated with narrowing or widening income disparities within developing countries is a matter of controversy in the economic literature. The standard trade theory, expressed in the Heckscher-Ohlin model, predicts that DCs should experience egalitarian trends as a consequence of globalisation. One of the most important corollaries of Heckscher-Ohlin’s model (H-O) is the Stolper-Samuelson (S-S) theorem. According to this main building-block of the theory of international trade, openness will benefit a country’s relatively abundant factor, since trade specialisation will favour sectors intensive in the abundant factor. Taking into account that most DCs – when compared with the world economy – are relatively abundant in unskilled labour and so have a comparative advantage in this production factor, openness should increase the demand for the unskilled workers and their wages, so ending up with an overall decrease in wage dispersion and within-country income inequality. However, if the basic dichotomic framework depicted by the HOSS framework is extended to account for multiple skill-related categories of workers (Wood, 1994), country groups (Davis, 1996) and traded goods (Feenstra and Hanson, 1996), the main distributive prediction of the HOSS theory is theoretically undetermined and depends on the relative weights and directions of trade flows. Moreover, if the HOSS assumption of homogeneous production functions1 among countries is relaxed, then international openness may facilitate technology diffusion from High Income Countries (HICs) to Low and Middle Income (LMICs) ones, and it is very likely that the new technologies are more skill intensive in relation to those in use domestically before trade and FDI liberalization. If such is the case, then openness – via technology – should imply a counter-effect to the HOSS theorem prediction, namely an increase in the demand for skilled labour, an increase in wage dispersion and so an increase in income inequality (see Lee and Vivarelli, 2004). The rather different results from empirical evidence actually support the idea that some other mechanisms, beside the HOSS theory, may be at work. An increasing amount of country- specific empirical works have shown that many DCs experiencing drastic trade liberalisation have, in fact, experienced a generalised increase in the relative demand for skilled labour and hence a rise in inequality. However, the evidence from cross-country empirical papers is mixed and has failed to reach a clear-cut conclusion about the sign and the strength of such a relationship (see Lee and Vivarelli, 2006a and 2006b) 1 That is, the same technology and absence of scale economies. 3 This paper contributes to this literature by presenting new empirical results based on a unique dataset including 70 developing countries over the 1980-1999 period. Most previous cross-country studies on inequality used the World Income Inequality Database (WIID)2 whose coverage is sparse and unbalanced. The Gini coefficients in WIID are based on different income definitions (income/expenditure, gross/net), different recipient units (individuals/household) and population coverage (urban/rural/all). Even when adjustments are made to improve data comparability3, these differences may still result in serious data inconsistency. Indeed, the first novelty of this paper is the use of an alternative global inequality dataset – the UTIP-UNIDO database4 – which ensures data comparability both through time and across countries. The second novelty of this paper regards the econometric specification and the estimation technique. Given the revealed persistence of the within-country inequality indexes, we use a dynamic specification (a lag of the dependent variable is included as an explanatory variable) which allows us to account for the path-dependent nature of the distributional pattern. The resulting endogeneity problem is addressed by using a Least Squares Dummy Variable Corrected (LSDVC) estimator, a recently-proposed panel data technique particularly suitable for small samples. Finally, we disentangle import and export flows according to their origin/destination areas. Our results show that both imports and exports from/to HICs significantly worsen income distribution in Middle Income Countries (MICs). We interpret these findings by considering the interactions between a country’s economic integration and its technological upgrading. The remainder of the paper is organised as follows: in section 2, we critically discuss the arguments in favour of the alleged egalitarian impact of trade on within-country income inequality, mainly from a theoretical point of view. Section 3 presents the empirical model and explains the econometric specification (section 3.1). Section 4 describes the data and shows some descriptive statistics. Section 5 presents and discusses the results, while conclusive statements are derived in Section 6. 2. The literature The standard model used by economists to analyse the effect of trade on the relative returns to different factors of production is the HO model, which builds on the Ricardian theory5 of 2 The WIID is a comprehensive database built by the World Institute for Development Economics Research (WIDER), based at the United Nations University in Helsinki. It includes Deininger and Squire’s (1996) dataset, and it is regularly extended and updated. 3 For example, Vivarelli (2004) restricts the analysis to Gini Indexes based on nationally representative surveys and uses dummy variables to check for the remaining differences in the type of surveys; Bensidoun et al. (2005) uses only changes in Gini indexes based on the same income concept and reference unit within each country. 4 The UTIP-UNIDO Database is assembled by the University of Texas Inequality Project (UTIP) and includes two measures of inequality. See section 4 for a description of these data. 5 David Ricardo’s Principlesof Political Economy and Taxation demonstrated that it was advantageous for a nation to trade with another nation even if the first was more efficient in the production of all goods in absolute terms; what was required was, instead, that one country was relatively more efficient in one product or had a “comparative advantage” in that product. 4 comparative advantages by predicting patterns of trade and production based on the factor endowment of a trading region. In its simplest version, as reported in Wood

Load more